SEBI Panel recommendation on Growth of Alternative Fund Industry

The committee formed by the Securities and Exchange Board of India (SEBI) and headed by Infosys founder N.R. Narayana Murthy suggested a slew of tax reforms to create a favorable tax environment for investors and changes in existing laws to facilitate capital-raising by Alternative Investment Funds (AIFs) and boost entrepreneurship. 

Other issues addressed by the committee include how to unlock domestic sources of venture capital and private equity and other funds for AIFs; enable and encourage onshore fund management in India; and Reform the AIF regulatory regime to facilitate and optimize investments by AIFs.AIFs or money collected from high net-worth investors to invest primarily in unlisted securities and start- ups to promote entrepreneurship, more than doubled during the past year-outpacing traditional investment vehicles such as mutual funds and market-linked insurance products. To sustain & enhance this panel suggested following reforms:

• The Government should introduce a Securities Transaction Tax (STT) on all distributions (gross) of AIFs, investment, short-term gains and other income and eliminate any withholding of tax. After STT, income from AIFs should be tax-free to investors. The exempt income of AIFs should not be subject  to withholding tax of 10%; the exempt investors too should not be subjected to the tax. This will reduce tax disputes and enable enhanced & smooth collection of taxes.

 • The introduction of STT for private equity and venture capital investments, including SEBI-registered AIFs, should have parity with the taxation of investments in listed securities.

 • Given the high risk and relatively illiquid and stable nature of private equity and venture capital, it needs to at least be treated at par with volatile, short-term public market investments for taxation.

• AIFs and portfolio companies should be exempted from certain income tax provisions so that they are subjected to tax only when receiving dividend or interest income during the holding period or realize capital gains at the time of exit to promote investments into AIFs.

 • In recent, past has started losing out business to overseas jurisdictions such as Singapore due to current rate of 20% tax with 3 year holding on domestic AIFs for backing an entrepreneur. The loss of business to India results in loss of tax revenue that would have otherwise come to India & loss of employment opportunities. The panel suggested that AIF investments held for a year must qualify as Long-Term Capital Gains (LTCG) & 0% LTCG regime must apply to all SEBI registered AIFs to encourage investment in risk capital that creates new ventures, jobs, and encourages entrepreneurship.

• The central board of direct taxes should clarify that investors in the holding companies are not subject to the indirect transfer provisions. This will attract more foreign investors into India-centric private equity and venture capital fund vehicles.

• AIFs should be allowed to invest in charitable and religious trusts also.

• The Government should work on ways to unlock those domestic pools of capital including large capital pools from pensions, insurance, DFIs and banks, and charitable institutions, which currently constitute only around 10% of the total private equity and venture capital invested in India annually, should contribute more to develop the AIF industry.

• All banks, pensions, provident funds, insurance companies and charitable endowments must create an internal management system and utilize a minimum of 2-5% of the corpus to invest in SEBI-approved Category 1 AIFs. Also, the panel urged the regulators to increase the investment limits for banks and insurance companies in AIFs from the current 10% to 20% of the total corpus of an AIF.

• Domestic pension funds in India including the National Pension System and the Employee Provident Fund Organization should allocate up to 3% of their assets to AIFs by 2017, further rising to 5% by 2020.

 • Existing norm on investment limits for AIFs restricts diversification and should be done away Timely. It is recommended that restrictions placed by RBI limiting FVCI (foreign venture capital investor) investments to only 10 sectors should be removed. The rationale for this is that almost every  significant sector of the Indian economy is in need of private equity and venture capital and hence a wide array of sectors should be accessible to FVCI investors.

• The panel also suggested that SEBI change its eligibility norms for investors to invest in AIFs. The present norms require an investor to invest at least Rs.1 crore in an AIF. Any individual with a total annual income of at least Rs.50 lakh should be allowed to put money in AIFs if he is capable of identifying potential investments and its belonging risks.